A test for the markets

Posted by Cam Hui - January 11, 2017

Mid-week market comment: Arthur Hill at stockcharts recently observed that the Russell 2000 was in a tight consolidation range, which is characterized by a narrowing Bollinger Band. Such conditions tend to resolve themselves with volatility expansions which represent breakouts from the trading range.

His remarks about the Russell 2000 could also be applicable to the current conditions of the SPX as well. The key question is which direction will the breakout occur?

Clues from inter-market analysis

We can get some clues from market internals and the performance of other asset classes. Kevin Muir, writing at The Macro Tourist, pointed out that the “Trump trade” of long Russell 2000 and US Dollar, short gold and bonds has started to roll over after a huge rally since the election. These conditions suggest an environment of falling risk appetite.

Indeed, the chart below of long Treasury prices shows that the 20+ year Treasury ETF (TLT) has started to turn up after experiencing a positive RSI divergence.

The chart of the USD Index is also telling a similar story. In this case, the USD Index is starting to roll over.

Independent of Muir’s analysis, Barry Ritholz constructed a POTUS Index, which consists of a basket of shares of companies that Trump has praised (grey line) and a basket of shares of companies that Trump has disparaged (blue line). As the chart below shows, this pair trade has been flat to down for the past month, which is indicative that the euphoria over the Trump election is fading (annotations are mine).

Despite these headwinds, stock prices have been surprising resilient. How will the Trump transition team deal with the challenges in the weeks ahead?

A test for the market and the Trump team

Early in the week, CNBC reported that the Trump team’s strategy ahead of the confirmation hearings scheduled this week was to “flood the headlines so that no bad news gets through”. The “bad news” was presumably any negative confirmation hearings headlines for the numerous nominees, such as Jeff Sessions, for Attorney General, John Kelly, for Homeland Security, Rex Tillerson, for Secretary of State, Betsy DeVos, for Education, and so on.

But the Trump team has a different strategy this week: They’re going to make a lot of news. So much, in fact, that the bet is no one piece of bad news will break through the media clutter. It’s all about safety in numbers.

That’s why you’ll see a wave of confirmation hearings all scheduled for the same day on Wednesday — even as Donald Trump himself provides cover with a long-awaited news conference in midtown Manhattan on the same day. The newser is bound to generate a wave of tweets, blog posts, cable TV hits and newspaper headlines that Republicans hope will wash over any poor performances by Trump’s nominees on Capitol Hill. The idea is to flood the zone.

Unfortunately, the Trump transition team did not count on the news about how Russian intelligence’s possession compromising material on Donald Trump caused the Trump advisers worked with Russian agents (see WSJ article and report from the Guardian). I’ll spare you the salacious details of the story, which have were seen by by various news organizations but not published because the details could not be confirmed.

The lurid details of how Trump may have been compromised should be of only minor concern to the markets. What really matters to investors is whether this story has the potential to distract and hamper the incoming administration’s ability to pass its package of fiscal programs.

In other words, will the tax cuts get delayed because the Trump team has to face Congressional investigations about Russian influence? That’s the first test for the Trump team, and for market psychology in the days and weeks ahead.

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5 thoughts on “A test for the markets”

Amazing. I would rather be lucky than smart. In my December 21 posting I had felt that with the VIX scrapping the bottom and making a multi-year low it was the time to take the other side of the trade. Long Bonds, Short dollar, Long Gold and Long Emerging Markets (by default as they trade inversely to the U.S. dollar). In retrospect that was exact bottom.

In the old days people would look at the cover of magazines to gauge investor sentiment. The Business Week cover “Death of Equities” comes to mind when the Bull Market started. Barron’s has also had similar instances. The reason I bring this up is now we need to substitute Trump in place of the magazine covers. He is crowing about the high consumer confidence numbers and the Trump bump!!. The ultimate contrary position would be that the stock market is not making a minor top but a major top. All the ingredients are there : Bullish Sentiment, high valuation, extended bull market measured in time duration, divergence between the advancing stocks and the S&P 500 and the Federal Reserve itching to raise rates.

I would look for two days back to back for the market to drop 1-2% and that would be the tell.

Note that it was Republican John McCain who brought this unsubstantiated account of the possible compromise of Donald Trump to the attention to the FBI.

Now that the GOP has control of the White House and both houses of Congress, it would not be inconceivable for members of the establishment wing of the Republican Party to throw a maverick like Trump under the bus. If Trump were to blow up in some way, Pence would become president and he would be someone that the party could easily support.

I am not suggesting that this will happen, but there are wheels within wheels. There have also been suggestions made that the whole story of how Trump was compromised was payback by the American intelligence community (push us, and we have lots of dirt to hurt you).

Maybe it is just ‘confirmation bias’ that I am seeing a few of these things from a bullish viewpoint. That’s what makes a market.

I see these sideways corrections for the market indexes after such a huge first surge as a sign of strength not impending big downswing. Internally in the S&P 500, I am seeing that whenever the Trump industry winners correct, the Trump losers go up and the index doesn’t fluctuate much overall. To me that speaks to the general optimism around general business conditions with tax cuts, deregulation, trade protectionism etc. If the Trump losers were still going down when the previous winners (banks, industrial, small cap, energy) were also going down, I’d then agree that we are in for a big correction.

The situation with interest rates is also very bullish for stocks. My biggest worry for stocks was that bonds would fall after the Fed rate increase in December and Yellen’s hawkish statements following the meeting. Rates had already soar, killing the bond market between the election and the Fed meeting date. But after the meeting, they rose just for a couple of days and then they have fallen consistently. That was the turning point for the bond chart above. I also track the futures markets for projected Fed Funds rates at the end of 2017 and 2018. There again, the same pattern, two days up and since then falling as investors reduce there expectations of higher short term rates out a year or two. This has got to give professional investors a huge relief since if rates had continued up, the stock market and economy would have had the rug pulled out from under them.

My take on the Trump press conference today is that he will quickly and surely move on his core promises to the folks who elected him. That means the Mexican wall, America First trade policies, tax cuts for business and people, and repealing Obamacare. He likely believes if he does those things, those key supporters will ignore negative media on other nasty things. The more the media is negative, the faster and harder he will move to get those things done. That’s good for business and the stock market.

Cam Hui had posted a What if Trump delivers, a few days ago (A bullish case for Trump). So far, the bullish case seems to be playing out, as the indices are holding up (ignoring what is happening below the headline index number). Nothing seems to be rolling over here. Small caps rallied today. For now, the bull case seems to be playing out. So far, there is a Uber case for sentiment and a dirth of policy. VIX index cracked higher today, but came down at the end. Even the 10 year T Note did not rally much. Lots of Kool aide being imbibed, or so it appears by some metrics.

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